During the 2019 Legislative Session, a bill was pursued to expand California’s False Claims Act (CFCA) to tax matters under the California Revenue & Taxation Code (CRTC). Such an expansion would put taxpayers at risk and disrupt the state’s tax collection process, which is why such a bill should be rejected by the Legislature, just as it was this summer.

The federal False Claims Act dates back to the time of the Civil War and was enacted to penalize profiteers who were selling defective goods or who otherwise were defrauding the government. Today, roughly half the states have a state version of the federal False Claims Act, and the vast majority of them mirror the federal “tax bar”. 

This “tax bar” expressly prohibits application of the FCA to tax matters. Similarly, California’s FCA has excluded tax matters under the CRTC since its enactment in 1986. Legislation proposed during the recently-concluded Session would have up-ended that exclusion and allowed tax disputes to be pursued under the state FCA. This raises a number of problems.

The proposed legislation would open the door for private attorneys to bring legal actions against taxpayers in cases where the tax agency determined that no “false claim” was presented. In the few states that have enacted laws similar to California’s proposed legislation, there has been an explosion of a cottage industry where profit-seeking lawyers are indiscriminately filing questionable claims and demand letters in a shotgun approach to see what claims may “stick”.

The problem is that a number of taxpayers, especially small businesses, are threatened into paying the private attorney’s demand letter – not because they have committed fraud, but because they cannot afford a lengthy legal battle to defend themselves. For those cases that do proceed to litigation, 72% of actions brought by private attorneys were deemed frivolous and dismissed, according to a 2007 study conducted by the Columbia Law Review. In Illinois, where tax disputes are allowed under a state FCA, Bloomberg Business BNA obtained evidence under the Freedom of Information Act that one law firm alone has filed more than 900 FCA cases.   

And, we all know what to expect in California, infamous for its litigiousness. Just look at California’s experience with similar litigation abuse under the state version of the Americans with Disabilities Act (ADA) and the ensuing “drive-by lawsuits”. Or the frivolous civil suits brought under the Private Attorneys General Act (PAGA) to enforce alleged violations of California’s Labor Code that did not harm employees. And, who can forget the rampant abuse of Business & Professions Code Section 17200 lawsuits against nail salons, auto repair shops, and others that ultimately had to be curbed by the electorate when they adopted Prop. 64 in 2004. 

The bill also disrupts the state’s tax collection and administration process. In Illinois, the general counsel for the Department of Revenue (DOR) reported that private attorney actions (similar to the ones uncovered by Bloomberg BNA) “interfere with the department’s authority to administer and enforce tax laws” and “have obstructed the DOR’s ability to settle compliance problems, carrying real revenue consequences to the state.” 

At the same time, taxpayers could suffer from a form of legal double jeopardy. In Illinois, private attorneys brought suit against taxpayers who had received rulings from the DOR approving their tax treatment. And others found themselves having to defend their tax position after surviving DOR audits with no adverse finding on the issue. While it costs private attorneys little to write a demand letter, there are considerable costs to taxpayers to investigate allegations and to fight frivolous demand letters and claims in court – even after the tax agency gave them a “clean bill of health”.

To make matters worse, the proposed legislation would apply evidentiary requirements that are typically reserved for more clear-cut issues to tax matters where one or more conflicting tax provisions could apply to the same transaction, depending on all the other factors related to that transaction. That is why the CRTC has its own standard of proof, definition of fraud, and statute of limitations that is independent from those under the state’s FCA. 

Lowering the standard and burden of proof and the definition of fraud, as well as extending the statute of limitations for legal actions (as proposed in the CFCA legislation,) would put taxpayers taking a legitimate tax position concerning a less-than-clear provision of law at significant risk of treble damages and other costs. This approach also wipes out a fundamental reason for establishing a body of tax law – taxpayer certainty. Taxpayers deserve to know in advance how they will be treated.

And, one final observation, what is the need for this bill?  None of the tax agencies in this state, long known for their aggressive enforcement of California’s expansive tax laws, have asked for this bill. None of them have reported large-scale fraud in this state or that they are short of resources to prosecute cases of tax fraud.  Moreover, California’s tax agencies have robust tax fraud laws and enforcement tools at their disposal. Yet none of them have said that the state’s tax laws are inadequate to combat cases of fraud.

Instead, a better approach is to strengthen the existing whistleblower program with financial incentives, similar to the very successful programs offered by the IRS and other states. This would be a more feasible and cost-effective alternative to allowing private attorneys to bring lawsuits into our already overburdened and underfunded civil courts. All of these points justify why an expansion of California’s FCA is unwarranted at this time.